Image: HR Magazine.com.uk
“DEFENSE NEWS“
“There’s a phrase — the mid-market squeeze — that encapsulates a truism in defense contracting: If you’re not really big, and you’re not categorically small, then you’re going to have a harder time competing. “
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“That is oversimplifying the issue, but there are practical reasons for this to be at least notionally true. Agencies and prime contractors both have set-aside goals that they’re expected to meet in terms of divvying a percentage of contract dollars to small businesses — goals they notoriously miss. That makes a small business designation for a company a valuable marketing tactic when competing to be on the team of a prime or to win a contract direct from a defense agency (less common, but it happens). I wouldn’t say it makes competition for small businesses simple, but it helps.
At the other end of the spectrum, you of course have the prime contractors, who have both the benefit of a direct relationship with the customer and, at least for the top tier, the sheer scale to meet more requirements at a lower cost.
That leaves the mid-tier suffering the Jan Brady effect.
And it stands to get worse as some of the biggest mid-tier players — cognizant of the squeezeand the benefit of scale — combine. The challenges of the midmarket were definitely a factor in the L3-Harris merger that closed July 1, Bill Brown, chairman and CEO of the newly formed L3Harris Technologies, told me during an interview ahead of the Paris Air Show.
The squeeze is driving consolidation and frankly is why there’s not many mid-tier players left, he said. “L3 and Harris were two; put them together and they become bigger.”
It’s a simple concept that nonetheless stands to redefine what a mid-tier company actually is — or, more accurately, to create a whole new category unto itself. L3Harris still doesn’t build platforms — Brown is quite adamant about that, as was Raytheon CEO Tom Kennedy when I spoke to him about the merger with United Technologies. That used to be a qualifier for the mid-tier — creating systems that often go in and on platforms built by the tier-one manufacturers.
But now, the fact that these merged companies are or will be large enough in terms of revenue to rival some of those tier-one defense manufacturers makes them quite different. What we have in L3Harris and the future Raytheon Technologies are companies with phenomenal scale and diversity.
We’ve watched a similar market shift among the IT services companies in the last few years, with medium companies combining to become mega providers that can price low, and offer more.
So where does that leave the other mid-sized defense companies? Probably looking around to see who they could perhaps merge with to leapfrog to that new category — or close to it. That’s not easy, though. As Brown noted, the pickings are becoming increasingly slim. And other factors matter: lack of market overlap, namely, to ensure a merger won’t raise antitrust issues and will promote diversity to put together more comprehensive systems.
If you look at this year’s Top 100 list, it’s hard to identify mergers that would fit the bill — though as Brown told me in June: “I wouldn’t have seen six months ago United and Raytheon.”
Me either.
Plus, with big mergers come divestitures. L3Harris expects a “pretty significant” piece of business to be shed either as a sale or a spinoff in its first six months. One can figure the same from Raytheon and UTC, once the deal closes. That provides options for those mid-tier players looking to expand.
And down the road? Who knows. These things often happen in cycles, where an era of consolidation makes companies a whole lot of money, and then a couple years later they break up.
As Brown and L3Harris Chief Operating Officer Chris Kubasik told me: “It’s worked for bankers.”
https://www.defensenews.com/opinion/editorial/2019/07/22/whats-left-in-the-dust-of-a-massive-merger/
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